This essay is based on the Premium Update posted on September 16th, 2010
It seems that demand for gold is rising faster than supply. It doesn’t take a degree in economics to understand that if the price of something soars by some 350% you would want to dig more of it out of the ground and sell it. But mine production has remained flat even as investor demand more than doubled so far in 2010 compared to a year earlier.
Looking back at recent history the best year for mine production was in 1999 when 83.69 million ounces of new gold came out of the ground. Keep in mind that in that year the price of gold was under $300, hitting a low of $256.
Last year’s mining production hit only 74.46 million ounces, still not enough to surpass 1999's output. So we’re not seeing dramatic increases in mine production. Central banks around the world who were permitted under an international agreement to sell a combined 200 tonnes per year, are not even selling an ounce. Just the opposite--they are net buyers rather than sellers.
Scrap gold (people’s old jewelry etc.,) is another source of gold coming to the market.
Over the last few years, since the financial crises unfolded and gold prices have gone up, people have been lured by advertisements on late-night television to take out their old gold jewelry and sell it for a profit. So that in 2008, while new mine production barely inched up by 1.38%, scrap gold soared by 34%.
But there is a limit to the number of grandma’s old gold rings people can sell. World Gold Council figures for the first quarter of 2010 show that scrap sales for this period were 11.03 million ounces, a 43% fall from the first quarter of 2009. Demand is growing but supply isn’t. Again, you don’t need an advanced degree in economics to understand the long-term implications for the price of gold.
Two important developments are seen in this week’s long-term GLD SPDR chart. (Charts courtesy of Stockcharts). Gold has moved above its previous high and it has done so on huge volume. Focusing on volume for a moment, most spikes similar to what has been seen of late have resulted in continuation of rallies although some consolidation normally takes place first. (click to enlarge)
A notable point needs to be made about a similar volume spike seen this past May.
The subsequent rally was followed shortly thereafter by a four-week decline to levels in late-July which were lower than those seen prior to the rally. In other words, the volume spike was followed by a rally, which was then followed by a sharp decline with only an occasional small correction interrupting what turned out to be a steady, month-long downtrend.
The possibility that this type of pattern could repeat itself must be kept in mind even if gold rallies from here. This doesn't change our opinion regarding one's long-term investments - we remain bullish on the metals here and we believe one should hold them regardless of the possibility of the short-term correction.
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